Municipal/Local Government DebtRefunding Tax-Exempt Muni Bonds

Refunding Tax-Exempt Muni Bonds

By August 28, 2012 No Comments

Below is an example of the refunding of tax-exempt bonds issued by a unit of government. Generally, it’s the kind of refinancing we all like to do when interest rates decline and we can take advantage of interest rate savings after debt is issued. The example uses a State as obligor/issuer though, generally, the same rules apply to municipalities and special districts. The intricacies of the calculations are precise and instructive. However, while reading the example, keep a view to the broader problems facing increasingly insolvent municipalities and special districts.

In the example, State issues bonds to construct a building within its University system. Later, when interest rates decline, State issues additional bonds to refinance the existing bonds to take advantage of the attendant cost savings. The example assumes a solvent State. For our purposes, assume an increasingly insolvent municipality or special district – then the problems start to become apparent. The once-solvent municipality or special district that is not as bankable as it was may not be able to refinance. Revenue bonds look unattractive to buyers because declining revenues won’t support debt service. General obligation bonds look unattractive because the local taxpayers may already be over-burdened with past bond and pension obligations, are reluctant to approve additional debt and, in the worst case scenarios, taxpayers are not paying taxes or are leaving the area. A once solvent municipality or special district may soon be rated as junk or near-junk.

Please click the link below to read the technical application of tax-exempt refunding of Muni bonds:

http://www.irs.gov/pub/irs-tege/part2d02.pdf

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